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Thursday August 18th, 2022

Sri Lanka’s central bank needs accountability and restraint, not independence: Bellwether

ECONOMYNEXT – Sri Lanka’s Central Bank Governors have to be legally restrained from injecting liquidity using the absolute discretion available through ‘flexible’ inflation targeting cum output gap targeting and not given more room to print money through central bank independence.

Multiple central bank governors especially after 2015 printed money using ‘flexible inflation targeting’ and output gap targeting (stimulus) to create monetary mayhem, borrow dollars excessively in the forex shortages that followed and drive a country at peace into default.

Currency crises were created in 2015/2016, 2018 and 2020/2022. There was also a currency crisis in 2011/2012 in the middle of an IMF program similar to 2018 one.

The absolute discretion available through flexible policies have to be restrained by rules based monetary policy.

Output gap targeting or stimulus

It was done through flexible inflation targeting with a flexible exchange rate and output gap targeting which in laymen’s terms means printing money in the hope of boosting growth.

However Sri Lanka has a pegged exchange rate regime, called a flexible exchange rate and whenever money is printed for flexible inflation targeting or output gap targeting, there is a currency crisis. There is no point in giving ‘central bank independence’ for the central bank to engage in open market operations, buy Treasury bills and drive a country at peace into default.

One may argue that the output gap targeting of 2020-2022 was part of the Saubhagya Dekma manifesto which promised a ‘production economy’ through a developmental state where taxes were cut and money had to be printed to stop the released taxes from coming back to the budget. The people, therefore, voted for the manifesto of the economic cranks.

However, no such justification can be given for the money printing from 2015 to 2018 which created two currency crises and ratcheted up sovereign bonds and Ceylon Petroleum Corporation borrowing as forex shortages emerged from output gap targeting.

Output gap targeting was not part of the manifesto

In fact, the Yahapalana manifesto promised a social market economy. A social market economy cannot work with currency depreciation but strong a currency and possible appreciation against the US dollar if the Fed prints money as the Bundesbank did.

A social market economy becomes an export and domestic economic powerhouse by providing a strong exchange rate with low inflation.

It provides stability to the family economy by preserving the real value of wages of the father and mother and the pension and savings of the grandmother and the grandfather, and the tiny deposits of the children, who save one cent by one cent (sathaya sathaya).

The constitution of the central bank should protect the people against all interventionists whether they are monetary cranks leaning towards modern monetary theory or the post 1930s Keynesian interventionism.

Flexible Shocks

Nobody bargained for the International Monetary Fund to teach the Yahapalana central bank to calculate an output gap. Nobody bargained for the central bank to print money when that policy fright administration failed to reform and trigger two currency crises shattering the voter’s incomes and savings.

Nobody bargained for Real Effective Exchange Rate Targeting where the currency was deliberately destroyed to keep a REER index below 100 and give unfair short term advantages to exporters at the expense of a voting public.

Nobody bargained for yield curve targeting where the central bank – prevented by public opposition from buying Treasury bills from auctions – would buy them from banks through term reverse repo auction.

Nobody bargained for the ‘bills only policy’ established by then Governor A J Jayewardene to be callously discarded without so much as a by your leave on the altar of output gap targeting and yield curve targeting and central bank to buy not only Treasury bills but also Treasury Bonds.

Nobody bargained for the central bank to print money in 2018 for output gap targeting, and trigger currency crises when taxes were raised by Mangala Samaraweera and Eran Wickremeratne.

Nobody bargained for the multiple currency crises which triggered forex shortages and the central bank was unable to buy dollars for rupees to settle dollar loans and instead ratcheted up sovereign bond holdings.

China also had to give budget finance loans to settle its liabilities due to forex shortages triggered by flexible inflation targeting cum output gap targeting.

Nobody bargained for the CPC to ratchet up its borrowings as forex shortages were triggered by ‘flexible inflation targeting’ cum ‘output gap targeting ‘and for the state banks to be bought to the brink of collapse.

Nobody bargained for the CPC to be barred from buying dollars for rupees, and for it to ratchet up dollar borrowings instead of buying dollars for rupees generated by Mangala Samaraweera’s price formula and for the rupee to be deposited in state bank repos after flexible inflation targeting.

Nobody bargained for Samaraweera’s price formula to be betrayed by flexible inflation targeting and central bank independence.

Impossible Trinity

A flexible peg with output targeting is subject to what is known as the impossible trinity of monetary policy objectives.

In fact, there has to be a commission of inquiry on how the CPC was barred from using the money from the price formula to buy dollars and was instead made to get suppliers’ credit and run up massive dollar loans in exactly the same way as the government borrowed through ISBs and China budget support loans to run up foreign debt and eventual default.

That central bank independence solves monetary problems is a Western myth.

Monetary problems are created by Anglo-Saxon flexible policy and output targeting by central bank governors who believe in what was taught at Cambridge, Oxford, Harvard and a host of saltwater universities even now. The IMF is no better. It also draws from the same universities.

Currency crises are created by third rate monetary policy where exchange and monetary policies conflict.

There are two regimes that work without conflicts.

Clean floating exchange rate regimes are found in developed countries, where the monetary base is entirely created by domestic assets (open market operations) and its growth is controlled by an inflation target.

In a hard peg or mostly consistent pegs, the monetary base is created entirely by foreign assets and the short term interest rate floats. There is no fixed policy rate enforced by money printing.

All other regimes, called soft-pegs, managed floats, dirty floats or the latest fashionable label, flexible exchange rates that are found in poor third world countries, Africa and Latin America, are intermediate regimes that collapse and depreciate.

It is practically not possible for a floating rate regime to experience a currency crisis (the central bank does not buy or sell foreign exchange for imports or any other purpose).

But soft-pegged countries do and it comes into conflict with the policy rate and they go to the IMF often.

And because the IMF gives loans to the central bank in a bailout it must operate a peg and buy dollars in the market to repay the loan. Therefore an IMF bailed out country will never graduate into a first world monetary regime.

The economists in the troubled country may also have a belief that they do not deserve a floating rate.

It may be due to an inferiority complex or simple fear of floating.

They also fear or do not believe an exchange rate can be fixed through a credible regime such as a currency board, even though with their own eyes they can see countries that do it, but their country has not done so in their own lifetimes.

The US does not want countries to fix their exchange rates in a false belief that East Asia became export powerhouses at the expense of the US with fixed exchange rates which are undervalued.

Therefore the IMF peddles flexible inflation targeting and ends up de-stabilizing them.

Singapore did not believe in output gap targeting

The reason many countries set up central banks in the last century was to print money and have discretionary policy. Inflation targeting emerged as a method to curtail that discretion or independence.

True inflation targeting with a clean floating rate also curtails central bank discretion and eliminate its independence or freedom to print money, somewhat like the gold standard.

Like a currency board, a low inflation target commits it to raise rates without discretion as soon as inflation picks up.

Output gap targeting using central bank credit does the opposite.

According to historians, the IMF repeatedly advised Singapore to set up a central bank. R W Goenman, an expert retained by the government to advise on currency, had supported a central bank.
https://mothership.sg/2021/10/sgd-history-central-bank/

However Goh Keng Swee, an LSE educated right-hand man of Lee Kwan Yew set up a currency board with the Finance Minister as Chairman.

“It is also not surprising that when the Monetary Authority of Singapore (MAS) was set up, the Chairman was by law the Finance Minister,” Goh said at the 30th anniversary of that agency.

“World Bank experts advised us against this since the Chairman should be an independent person with sufficient authority to resist a Finance Minister’s request for money to finance a budget deficit.

“The World Bank believed that putting the Finance Minister in charge would be like asking a cat to look after fish.

“But Singapore has always worked on the principle that government expenditure on education, defense, social and economic services, etc, must be paid for out of government revenues — taxes and fees.

“Successive Finance Ministers have been doing just this. They do not need an independent Central Bank Governor to persuade them not to run budget deficits. The World Bank’s anxieties were misplaced.

“The way to a better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the workplace. Diligence, education and skills will create wealth, not Central Bank credit.”

However under flexible inflation targeting cum output gap targeting the central bank printed money to close and output gap, triggering currency crises.

Economy Smashed

When a flexible exchange rate collapses, the economy has to be smashed to restore credibility. After money is printed rates have to be spiked to very high levels, such as now, the exchange rate has to collapse, governments have to change, and people have to suffer.

The problem is not holding the exchange rate as falsely claimed by Keynesians. The problem is printing money to keep rates down which makes the peg lose credibility. Then the economy has to be smashed to save the soft-pegged rupee. The economy is smashed not because it is sick, but because the soft-peg is sick.

By an elaborate ideology, mainly through repeating without any logic, people are made to believe that the fixed exchange rate is at fault, and not money printing and flexible policies.

Then people have to be taxed heavily to pay the public sector salaries because the economy shrinks as rates are raised to save the soft-pegged rupee.

Saving the rupee also saves the bank deposits. However, it is touch and go. Sometimes banks fail when the economy is smashed to save the flexible exchange rate.

If a liberal or socialist government is in power, nationalists come to power as the economy is smashed to stabilize the currency. If nationalists are there, liberals can come to power. However, if flexible inflation targeting and output gap targeting is continued with central bank independence, as in 2018, they will not last long.

Repeating Cycles

Under flexible exchange rate inflation falls to near zero in about 16 to 20 months after a currency crisis. Under flexible inflation targeting interest rates are cut when that happens, which coincides with credit recovery. It then triggers another currency crisis.

If there is enough commercial debt, they default as well. Then the cycle repeats. Therefore the country is doomed to operate a flexible exchange rate and have repeated currency crises and permanent depreciation.

Politicians are usually willing to take tough decisions after the central bank destroys the economy. JR did it, Samaraweera did it, President Rajapaksa is starting to do it.

However, whatever they do, the central bank will print money using its independence and trigger a currency crisis when the economy recovers, including when the politicians raise taxes, as happened in 2018.

Sri Lanka is now experiencing its first default. This column warned from around 2016, when the flexible inflation targeting/call money rate targeting started that downgrades would follow and that the country will default on foreign debt like the Weimar Republic. Under flexible inflation targeting and output gap targeting with central bank independence, it is inevitable that the cycle will repeat.

Now that is done once, Sri Lanka will become a serial defaulter.

A draft monetary law prepared to institutionalize the 2015-2019 flexible policy debacles has the tools to create similar disasters in the future.

According to one draft Article 7 (1) (a) gives the agency the power to “determine and implement money policy” and (1) (b) gives it the power to “determine and implement exchange rate policy” setting off an inherent policy conflict.

How can a central bank with an “exchange rate policy” operate inflation targeting. In inflation targeting reserve money has to be pegged to inflation not the exchange rate or the balance of payments.

A J Jayewardene when he started the central bank on the path to inflation targeting removed an original objective of preserving the “external value of the rupee” for this very reason.

Killer Discretion

Section 11 is a killer.

“There shall be a Monetary Policy Board of the central bank which is charged with the formulation of monetary policy of the Central Bank and the implementation of flexible exchange rate regime in line with the flexible inflation targeting framework in order to achieve and maintain domestic price stability”

Surely this is a joke? It sets into law the domestic and external anchor conflicts that lead to forex shortages, epitomizes the impossible trinity of monetary policy objectives trigger currency crises.

Argentina in 2018 was flexible inflation targeting and had 17 percent inflation when it collapsed.

Flexible inflation targeting and central bank independence will not help. There is no point in giving independence to central bankers who want to follow discretionary or flexible policy.

There are no guarantees that a Keynesian will not become a central bank governor in an independent central bank. There has only been one non-Keynesian governor in its 1972 year history.

Even if a non-Keynesian comes he will be tripped up by the foreign reserves.

If the central bank truly wants inflation targeting, it has to float the currency, stop acting as the banker to the government, and set up an office in the Treasury to buy foreign exchange for rupees to settle dollar debts and the central bank has to stop collecting reserves.

If not Sri Lanka has to set up a currency board. And do the same thing. Currency board profits can be transferred to a sovereign wealth fund which can be used for bank bailouts and ‘stimulus’ if the government wants.

The new law is a bigger disaster than the current one. To do what was done in the past 7 years the Monetary Board had to violate the main objectives of the current law. Under the new bill, it had be done with no violation as full discretion will be given.

What is needed is not central bank independence, as touted to Singapore by the World Bank and IMF to Sri Lanka, but central bank accountability and an agency that will be restrained by rules to block discretion involving output gap targeting and flexible policy.

This column is based on Price Signal by Bellwether published in the April 2022 issue of Echelon Magazine.

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Sri Lanka rupee, yields in govt securities slightly changed

ECONOMYNEXT – Sri Lanka Central Bank’s guidance peg for interbank transactions weakened on Thursday (18) and yields in Treasury bonds picked up slightly while in T-bill edged down in dull trade after the central bank kept key monetary policy rates steady, dealers said.

On Thursday, before the market opened, the central bank held its key policy rates steady at 15.50 percent, while data showed market interest rates are close to twice the rate of them while private credit and imports falling as a consequence.

The central bank is injecting 740 billion rupees of overnight money to banks at 15.50 percent, which were originally injected mostly after reserves were sold for imports (or debt repayments) to artificially keep down rates (sterilized interventions), effectively engaging in monetary financing of imports.

The injections (sterilizing outflows) prevent the credit system from adjusting to the outflows and encourage unsustainable credit without deposits, which is the core problem with soft-pegged central banks, triggering a high rate and an economic slowdown later.

A bond maturing on 01. 06. 2025 closed at 27.90/28.00 percent, slightly up from 27.75/90 percent on Wednesday.

The three-months bill closed at 28.30/29.25 percent, down from 29.25/30 percent on Wednesday.

Sri Lanka’s central bank announced a guidance peg for interbank transactions weakened by one cent to 360.97 rupees against the US dollar on Thursday from 360.96 rupees.

Data showed that commercial banks offered dollars for telegraphic transfers between 367.97 and 370.00 for small transactions.  (Colombo/ Aug 18/2022)

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Japan grants medical equipment worth 500-mn yen to Sri Lanka govt hospital

ECONOMYNEXT –  The  Japanese government has granted medical equipment worth 500 million Japanese yen to the Sri Jayawardenepura government hospital to improve the hospital’s treatment facilities under Japan’s Non-Project Grant Aid Programme.

A statement by the Department of External Resources said the grant was given in response to a request by Sri Lanka’s government.

Under the 500 million Japanese yen (approximately 1,265 million rupees) grant assistance, angio-CT machine, other radiology equipment, ophthalmic instruments, surgical instrument sets (stainless steel with satin finish), 15 dental units with accessories, liver transplant instrument sets, and a cardiac catheterization laboratory will be provided, a statement said on Thursday August 18.

Sri Lanka due to its worst economic crisis in its post-independence history is currently facing shortages of essential medicine, non-essential and lifesaving medicines pressuring the health sector to only attend to emergency cases to preserve available limited medicine stocks.

On Thursday at the policy rate announcement media briefing by the Central Bank of Sri Lanka (CBSL), Governor Nandalal Weerasinghe said, with the strict measures taken in the recent past, Sri Lanka is currently managing the limited forex income coming into the country to purchase essential goods such as fuel and medicine.

Sri Lanka has received various grants from several countries including China and India which gave a 200 million US dollar credit line to purchase medicine from India.

In June, Minister of Health Keheliya Rambukwella said there is no shortage of vital medicines in the country and all medicines will be restocked by August 2022. However, shortages of medicine aer still being reported in various hospitals islandwide.

“This improvement at the hospital will facilitate the enhancement of the quality of the care provided especially to the patients with non-communicable diseases while enabling high quality medical professional training to medical undergraduates and postgraduates from the National School of Nursing at the aculty of Medical Sciences of the University of Sri Jayawardenepura,” the External Resources Department statement said.

“This project will eventually assist the development of human resources of the health sector in Sri Lanka,” it said. (Colombo/Aug18/2022)

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Sri Lanka immigration on the hunt for Scotswoman who documented protests

Kayleigh Fraser via @kayzfraser Instagram

ECONOMYNEXT – Sri Lanka’s Immigration and Emigration Department is attempting to track down Kayleigh Fraser, the Scotswoman who documented the country’s anti government protests.

Fraser was ordered to leave the island on or before Monday August 15 after officials cancelled her visa. She and her lawyer had filed a writ petition against her deportation with the Supreme Court, which was dismissed on the grounds that she was not being deported deported, only had her visa cancelled.

“The learned State Council submits that the impugned document ‘X4’ is not a deportation order as claimed by the petitioner and she confirmed that no deportation order has been made up to date by the authorities against the petitioner,” a court document shared by Fraser said.

Immigration officials stated that the police and SSD were on the lookout for Fraser.

“Her visa was cancelled on August 15, so we are looking to put her in a detention camp until she can get a ticket to leave the country,” the official told EconomyNext, confirming that Fraser was not getting deported but that her visa was cancelled.

“Legally we cannot give her a grace period, but on a humanitarian basis, we can give her the time to get a ticket,” the official said.

Fraser had used her social media to share pictures and videos of the anti-government protests in front of the Presidential Secretariat, and has been vocal against state sanctioned violence against protestors.

“Given what I have witnessed here in Colombo – the chemical weapons attacks on protestors, the government instructing the military to beat and torture protestors, the arbitrary arrests and blackmailing of prominent faces from the protests, intimidation tactics and threats etc – I should not be surprised at what has happened today,” she said, speaking to the Daily Record, a Scottish tabloid.

There were no reports of chemical weapons being used against any protestors in Sri Lanka, and it is unclear whether Fraser was erroneously referring to tear gas which was used to disperse crowds.

Fraser also called out media channels who she claimed had attempted to misrepresent peaceful protests as violent.

“It became very clear to me early on that this was not being reported. There was no international coverage on what was happening, and the media here were very much trying to say that it was violent, but that is the absolute opposite of what I saw,” she said over social media.

“What I saw was a beautiful union [of people] coming together in absolute unity. It was a beautiful movement and I’ve never seen anything like that in my life and that kept me coming back.”

However, Sri Lanka’s authorities maintain that the arrests so far have been legal and that violence did occur on the part of some protestors, though activists and some civil society groups disagree. On May 09, after supporters of then Prime Minister Mahinda Rajapaksa launched an unprovoked attack on peaceful protestors in Colombo, a wave of retaliatory mob-violence erupted across the country which saw the residences of some parliamentarians torched to the ground. One government MP was killed.

Authorities say many of the arrests so far have been of protestors who had violated court orders or had illegally occupied government buildings.

Fraser continues to post on her social media. (Colombo/Aug18/2022)

 

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